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I believe the success of this ambitious reform package will depend in large part on its ability to address too-important-to-fail. By removing this Damoclean sword hanging over the modern financial system, policymakers could score an epic financial stability victory. At the heart of this issue lies the expectation that governments will stand behind systemically important financial institutions in times of trouble. These institutions can reap the benefits of this implicit public subsidy through artificially lower funding costs, excessive risk taking, and taxpayer-funded bailouts.
Policymakers have sought to shrink this implicit public subsidy by reducing the likelihood and cost of bank distress or failure... Despite these efforts, implicit subsidies to these systemically important financial institutions remain too large. We are working on new analysis of the implicit subsidies provided to these institutions that we will publish in April, so stay tuned.
I believe policymakers should focus on one of the key unfinished elements of the too-important-to-fail reforms—bank resolution, especially across borders. It is astonishing that officials in countries are still largely ill-equipped to deal with a Lehman Brothers-style bankruptcy, where assets and liabilities are scattered across multiple jurisdictions and entities.
Over the past year or so, we have seen some progress in this area, including agreements on the European Union’s bank recovery and resolution directive, and the planned European single resolution mechanism. We have also seen the continuing implementation of the United States’ Dodd-Frank legislation and the agreement in principle by officials in the United States and the United Kingdom to address cross-border resolution... But policymakers have yet to do much of the heavy lifting. For example, they need to remove legal obstacles to cross-border resolution in areas such as derivatives and national insolvency regimes. They also need to reach agreement on the amount, nature, and location of “bail-in-able” bank debt that should be available to absorb losses.
More broadly, cross-border resolution requires an unprecedented level of trust among officials in different countries. Building this mutual trust—through strong cooperation and uncompromising implementation of agreed reforms—would go a long way toward ending too-important-to-fail. It would also help avoid the risk of a gradual balkanization of global finance, because officials would be less likely to ring-fence the operations of global systemically important banks within national borders.
In the coming months, policymakers should heed the call to action by the Australian G20 presidency. By completing the reform agenda, they will make a major contribution to the global public good of financial stability, which underpins economic growth. But this regulatory supertanker is not yet ready to hit the high seas.
The G20 leaders should continue to fully support efforts by the Financial Stability Board to complete the reform agenda, and they should have the political will to implement it. The International Monetary Fund, in turn, will continue to contribute its resources and expertise to help address the remaining challenges, in collaboration with the Financial Stability Board and international standard setters. The IMF will also help its members implement the new rules in the coming years through surveillance and technical assistance.